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Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey

Author

Listed:
  • Davide Debortoli

    (Universitat Pompeu Fabra, CREI and BGSE)

  • Pierre Yared

    (Columbia University)

  • Ricardo Nunes

    (University of Surrey)

Abstract

According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time-consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not tax on the downward slopping side of the Laffer curve, even if it is ex-ante optimal to do so. In light of this finding, we propose a new framework to characterize time-consistent policy. We consider a Markov Perfect Competitive Equilibrium where a government reoptimizes sequentially and may deviate from the optimal commitment policy. We find that, in a deterministic economy, any stationary distribution of debt maturity must be flat, with the government owing the same amount at all future dates.

Suggested Citation

  • Davide Debortoli & Pierre Yared & Ricardo Nunes, 2019. "Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey," 2019 Meeting Papers 926, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:926
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    References listed on IDEAS

    as
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey
      by Christian Zimmermann in NEP-DGE blog on 2019-10-19 22:48:17

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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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